How to fix the financial system? Introduce radical openness.

Poor Alan Greenspan – his blunder at the congress hearing makes him look like the dumbest person on the planet. To trust that the Internet would make the financial markets safer and more transparent? What a naïve idea!

Why Alan Greenspan was right?

Actually, Alan Greenspan was right. The Internet has given us the possibility to make the world – and also this dark, muddy corner, called financial markets – safer, with more translucency and less shady secrets. And also filled with more trust.

This should be trust, not just faith. Trust needs proof and control. Trust means, I am not checking you all the time, because you have shown, that you can deliver good quality, or I just suppose it, until I do not experience the contrary. Faith is something else, it is without the power of proof. And it is more accurate to describe our present and past attitude – with the existence or the lack of it – to the major part of the financial services.

Especially with the coming of the 2.0 age, the Internet is an absolutely suitable playground to insure the health of the financial markets. But – as has been proven so lucidly by the present meltdown – something is missing.


Why Alan Greenspan was wrong?

Yes, on the other hand, he was deadly wrong. He believed, the Internet will be able to build up sufficient checks and balances against the incumbent – and most secretive – players of the market.

Maybe it can on the long run. Political blogging has changed the political discourse a lot, some secrets are uncovered, hybris is exposed much quicker, and with much more consequences than before, when it was enough to intimidate a handful of journalists and editors to cover up a story. Yet, it has taken more than 5 years to achieve something (the Trent Lott case happened in 2002).

It can coerce the established players to change their habits by orchestrating a revolution, smashing in bank portals, burning down the headquartets of financial institutions. We will not want this option.

There is the other, more organic way, the soft evolution where Internet users and bloggers and startups force out step-by-step more transparency. The downside is that it takes some 10 years. During this time our whole global financial system blows up. Three times.

Strengthening the regulatory structure, introducing strict rules, tons of new legislation, setting up new federal, state and international monitoring agencies, as suggested by so many people these times, would be nothing but counter-effective. It is the easy way, it would charm a lot of people, it doesn’t require much thinking. But if the interest of the financial service providers continue to contradict that much with that of the individual investors and other clients, this move does nothing more than slowing down the economy even more. Combined with the aging of the population in every industrialized nation and the deterioration dependency ratio, and our whole welfare system collapses in the coming ten years. Three times.


Is there a way out?

Paul Kedrosky is very close in his Newsweek article of October 27. He sais, we need something like a financial dashboard, that would interpret the numbers (and the opportunities and risks in behind), and we need to demand it from our personal-financial providers loudly. The problem is, they are not going to provide it. They are not (enough) willing to, and they actually can not do it. Maybe they will give us something look-alike or similar to it, but this will not help much.


1.) Incumbent financial providers are motivated the same old way: more transactions bring more money to them, and they are not much interested in the actual performance of our portfolio.

2.) They themselves do not have all the information to do it. Most of the information needed in advance, before making a decision to buy or sell a refined financial product, is only available after it: how it has actually delivered. But we – and our personal-financial providers – do not know, how these products have been developed, and the way how the financial institutions themselves have sized up their merits (opportunities vs. risks again) continues to stay in the dark.

3.) Therefore until we do not change the playground fundamentally, until we do not re-engineer the scene, the hit-and-run tactics, will be rewarded and the same old destructive practices will thrive forever.

Kedrosky suggests, we should have some access to the instant messaging between the traders. Exactly.That one too. But we need so much more.


Radical openness

Everybody wants to outsmart the market. There is nothing wrong about it, this is the main driving force of our economic system. On the financial markets, however, everybody wants to do this by using insider information. Few confess it, but the largest sex-appeal of most of the brokerage firms is their reach to behind-the-scene information. Or at least the pretense of having such information, and the willingness for giving these further. ‘Umm, we have information from our sources on the Street, what Warren Buffets next position is …’ Sounds familiar?

The trading of secrets is illegal even today. Not much would change with bringing in new regulations for the derivatives market.

What we need to do is wiping out secrets from the financial system. It should not be secrets upon which success and prosperity should be built, but rather on analyzing better the information at hand and on managing the resources in a more efficient way.


So, here is a primer, who to embrace the policy of radical openness:

1.) Obligate by legislation financial service providers to make ALL relevant information generally available in real-time, like:

– the IMs of brokers, financial institution leaders, analysts, etc. publicly available, as was suggested by Paul Kedrosky. Even better: send them to twitter.

– all information they give to the established rating firms, auditors

– all data they file to federal and state agencies, etc.

– minutes of board meetings. Even better: broadcast the meetings in real-time

 – all background analyses, studies, calculations they consider before coming to a decision.


2.) While legislation takes some time – measured rather in years, than months -, introduce this policy instantly at companies bailed out.

While there are some relative disadvantages of going open in the short run, it gives a longer term edge over the competition. The first ones to introduce will have some hard times, but they are having hard times anyway. If huge amounts of taxpayers’ money has been poured into financial institutions, full transparency is the least the citizens can expect in return for their contribution. Not just empty promises, that next time we will take care of your money better.

Otherwise, by introducing this policy at the same time at more major institutions distributes the short term relative disadvantages.


These steps would help to:

– Lower considerably the barriers of entry into the industry of analyzing and rating financial products. Empowering startups to proliferate in this field will – in turn – change the behaviour also the incumbent players. There are enough bright minds graduation from Stanford, Harvard, or the Delhi School of Economics, India, if you like, who would be eager to do this job.

– Reinstate trust and sincerity in the financial system. Funny words? Yes, and this one shows again, how ill our system really is in its present form.

– Gratify the sense of justice of the taxpayers, who see, that it is not just their life, what is changed by this meltdown, but also that of the main culprits.


Ceterum censeo

I believe, the policy of radical openness will come anyway (see the quiet evolution that the Internet inevitably brings about).

The only question is, how much are we waiting before we embrace it at last, and how much more damage should we suffer until its coming.


2 Responses

  1. […] financial institutions deserve the bailout – but it was the theme of an older post about bringing radical openness into the financial […]

  2. […] about centralized solutions, freezing regulations. Re-engineer the scene, introduce the policy of radical openness, empower disruptive companies to rise and serve the clients better than the incumbent ones. […]

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